## DEPOSIT INSURANCE TECHNICAL NOTE — MARCH 2013

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### I. Overview of existing deposit insurance arrangements in the EU
- Deposit insurance in the EU is provided by a variety of national deposit guarantee schemes (DGS) that "vary greatly in their coverage, contributions, fund sizes, and organizational setup."
- Some countries have more than one scheme (examples cited: Austria and Germany).
- Prefunding arrangements:
  - Many national DGS have limited prefunding or rely on ex-post funding mechanisms.
  - Countries relying exclusively on ex post funding: Austria, Italy, United Kingdom.
  - The Netherlands adopted regulation in 2011 to transform its ex-post DGS into an ex-ante funded scheme with risk-based contributions; the new regulatory framework will come into effect on July 1, 2013.
- Voluntary supplemental schemes:
  - German private scheme for commercial banks provides insurance "of up to 30 percent of bank capital per depositor," effectively offering "essentially unlimited coverage for most depositors." This coverage is to be gradually reduced to 8.75 percent over a span of 10 years, starting in 2015.
- Typical measures of DGS breadth in 2011 include: Eligible deposits/GDP, Covered deposits/GDP, and DGS fund size/GDP (member states referenced: AUT, BEL, CYP, DEU, ESP, EST, FIN, FRA, GRC, IRL, ITA, LUX, MLT, NLD, PRT, SVK, SVN).

### II. Harmonization: timeline, proposals, and constraints
- Timeline and legislative history:
  - Process began with the 1994 EU Directive on Deposit Guarantee Schemes.
  - Directive was significantly amended after the failure of Lehman Brothers.
  - In 2010 the Commission proposed comprehensive reform; draft DGS Directive of July 2010 has been under discussion since 2010.
- Key Commission proposals and aims:
  - Create a level playing field, with focus on coverage limits and preference for ex ante funding.
  - Harmonize scope of coverage (type of deposits).
  - Introduce common standards on financing; proposed target fund size of 1.5 percent of eligible deposits (eventually to be set in terms of covered deposits).
  - Introduce risk-based contributions.
  - Shorten payout periods (proposal: limited to seven working days).
  - Clarify responsibilities to improve insurance payments for cross-border banks; limited cross-border borrowing arrangements between national DGS.
- Measures implemented after the 2008 crisis:
  - Coverage level increased to €50,000 by mid–2009 and to €100,000 per depositor per bank by end–2010.
  - Maximum payout period shortened to 20 working days by end–2010.
- Political and procedural constraints:
  - Further harmonization suspended pending adoption of EU bank resolution arrangements through a new Directive on Bank Recovery and Resolution (BRR).
  - Co-legislators failed to reach compromise in 2011, mainly over potential use of DGS funds for resolution purposes in context of BRR.
  - BRR proposed a target pre-funding of 1 percent of guaranteed deposits within 10 years, and characterizes borrowing arrangements between resolution funds while allowing use of DGS funds for resolution if optimal protection of depositors.
  - Member states expressed willingness in July 2012 to pursue DGS negotiations in parallel with BRR negotiations.
- Key points of disagreement:
  - Disagreement about proposed size of funding (Commission original proposal: 1.5 percent of eligible deposits) and proposed timeframe to build up funds (Commission original proposal: 10 years).
  - Impact assessments indicate building up these funds over the proposed timeframe could "significantly reduce the profitability of an already weakened banking sector" in several member states, particularly when combined with increased deposit coverage.
  - One member state indicated no desire to move to an ex ante scheme with prefunding from the industry.
- Cross-border payout facilitation:
  - EC proposed that the host country DGS acts as a "single point of contact" for depositors at branches in another member state (including paying out those depositors on behalf of the home country DGS, which would subsequently reimburse the host DGS).
- Relation to banking union:
  - Developments occur in context of discussion on the banking union; proposed regulation establishing the Single Supervision Mechanism (SSM) was under consideration with a view to enter into force in 2013.
  - Although a pan-EU DGS was originally proposed, presently the SSM and establishment of the pan-EU bank resolution fund are given priority, with DGS harmonization to be pursued later.

### III. Principles and best practices for DGS
- Primary purposes:
  - Provide a safety net for smaller depositors and enhance financial stability.
  - Part of the "financial safety net" alongside bank supervision, emergency liquidity provision, and bank resolution/insolvency framework.
  - Distinction between guaranteeing (small) depositors and financing bank resolution.
- Variation in deposit insurer roles:
  - Roles range from broad monitoring and participation in insolvency proceedings to being limited to depositor payout and asset resolution or merely depositor payout.
  - Variation reflects public policy objectives, institutional strengths, legal frameworks, and resource availability.
  - Within the EU single market, level playing field and cross-border contagion risks imply need for harmonized safety nets and coordinated safety net agencies.

### Core characteristics for credible deposit insurance
- Appropriate coverage:
  - Authorities can design coverage to protect a target share of depositors (example: fully protect "80 percent of depositors and 20 percent of deposits").
  - In practice, coverage levels per depositor average about twice per capita GDP but vary widely.
  - The €100,000 coverage limit can be seen as high for a number of EU member states with relatively low levels of economic and financial development; harmonized coverage levels are important for the single market.
- Timely payouts:
  - Timely payouts reduce disruptions to the payments system and prevent panics and bank runs.
  - Some jurisdictions achieve payouts within 48 hours of the failure.
  - Where banks are subject to corporate bankruptcy law rather than special bank insolvency regimes, shareholder appeals and strong creditors’ rights can impose significant delays on depositor reimbursement.
  - Depositor preference (priority rights for insured depositors and the DGS) is missing in a number of national bank resolution regimes in the EU; depositor preference could increase recovery by the deposit insurer and might facilitate quick depositor payout and transfer of deposits to another institution, but could also increase funding costs of banks by increasing potential loss exposure of unsecured creditors.
- Adequate funding:
  - Systems can be ex ante funded (built up over time with bank contributions) or ex post funded (extraordinary charges on all banks in event of failure).
  - Ex ante funding may strengthen private sector confidence and enhance financial stability, provided risk is correctly priced.
  - Ex post funding may induce market discipline but can be pro-cyclical and is regressive as surviving banks bear the cost.
  - The Commission’s proposal calls for pre-funding of deposit insurance.
  - Government back-up funding is a prerequisite for credible deposit insurance to allow intertemporal smoothing of the fund; it can be used in case of shortfalls while money is recovered from surviving banks.
  - Convergence in treatment and ranking of depositor and other creditor claims in insolvency could promote cross-border cooperation and improve predictability of cross-border resolutions.

### Mandate, legal framework, and public communication
- Mandate clarity:
  - The mandate must be unambiguous, preferably spelled out in the law.
  - The role of the deposit insurer must be well established within the larger problem bank resolution framework.
  - Relationship with other agencies must be explicit, with communication and information sharing laid out in regulation or law.
  - The deposit insurance system must be informed immediately when a potential insolvency is identified so it can prepare for deposit payouts.
- Public outreach:
  - Awareness of the deposit insurance system’s existence and the terms and scope of its coverage is critical to stabilize depositor fears.
  - Public outreach activities must be extensive and frequent.

### Limiting moral hazard: scope, pricing, and complementary policies
- Scope limitations:
  - Coverage should relieve only small depositors of the burden of monitoring their banks.
  - Scope should exclude interbank deposits and “insider” deposits (bank managers, owners, and connected persons).
  - Shareholders and uninsured creditors of failed banks must not be protected.
- Risk-adjusted insurance premiums:
  - Banks should pay fees commensurate to their relative risk of failure.
  - Premiums can be adjusted by assigning banks to risk buckets and charging different premiums.
  - Currently, most EU DGS do not adjust premiums for risk and levy premiums that are not actuarially fairly priced.
  - Proposed recast of the DGS Directive would introduce contributions that consist of both non-risk and risk-based elements.
- Strong supervision:
  - Deposit insurance should be complemented with strong supervision and capital regulation.
  - Strong supervision combined with adequate capital requirements limits unsafe banking practices and reduces probability of failure.

### Funding, prefunding, and backstops
- Backstops and credibility:
  - Financial safety nets need fiscal backstops to lend credibility and deal with systemic crisis events.
  - Current national DGS within the EU lack a fully credible backstop for systemic risks due to absence of mutual borrowing arrangements and concerns about member states' ability to backstop national DGS.
- Mandatory schemes and pool expansion:
  - National deposit guarantee schemes should be mandatory, not voluntary, to provide a level playing field, avoid adverse selection, and reduce average cost by expanding the insurance pool.
  - Merging existing funds that operate in the same jurisdiction is generally preferable to expand the insurance pool (U.S. example cited: merging BIF and SAIF into DIF under the Federal Deposit Insurance Reform Act of 2005).
- Prefunding specifics:
  - Prefunding will be necessary; the DGS fund should be sufficiently large to cover depositor payouts and associated costs in most cases.
  - Pre-funded schemes in the steady state could operate with funds fairly small in size, though substantially bigger than currently in most member states.
  - Funds should be raised over time from the financial sector to reach the target size, and contributions should be risk based.
  - In systemic crises, government backstops are needed; taxpayer costs can be recouped over time from the financial sector.
- Operational practice example:
  - To ensure banks have sufficient liquid assets to contribute such funds, one jurisdiction requires all banks to invest a minimum of 2.5% of insured deposits in debt securities eligible for Eurosystem collateralization as defined by the Bank of Slovenia.

### Harmonization, cross-border issues, and the banking union
- Need for harmonization:
  - Harmonization of DGS across the EU is important to support financial integration and internal market functioning.
  - Substantial differences in coverage, pricing, and funding arrangements imply no level playing field and encourage regulatory arbitrage.
- Alignment recommendations:
  - Align national deposit insurance schemes in quantities (coverage limits) and prices (fairly priced premiums adjusted for risk).
  - Scope should be limited mainly to household and SME deposits.
  - The coverage level of €100,000 is described as broadly appropriate for most member states given their level of economic and financial development.
  - Differential coverage would be undesirable given the harmonization objective.
- Common funding within banking union:
  - Resolution frameworks need enhancement and harmonization by giving insured depositors and the DGS priority rights over the estate of a failed bank.
  - A common safety net is critical for a banking union to ensure funds are available to resolve bank failures and cover depositor payouts without endangering sovereigns or monetary stability.
  - Emphasis on common funding rather than operational centralization of deposit insurance.
  - Common or linked deposit insurance could be designed as a re-insurance scheme created from national DGS and funded at the banking union level through industry levies and member state contributions.
  - Over time such a fund would build administrative capacity and could be a step toward a permanent banking union scheme and resolution fund.
- Interim arrangements until common safety nets exist:
  - Funding arrangements should ensure orderly and credible resolution, including rapid deposit payouts.
  - Prefunding combined with loss-sharing agreements for cross-border deposit payouts and a common, credible backstop should national DGS run out of funds.

### Key policy recommendations (summary)
- Establish an unambiguous legal mandate for deposit insurers and explicit inter-agency communication and information-sharing arrangements.
- Limit scope of coverage to protect small depositors while excluding interbank and insider deposits and ensuring shareholders and uninsured creditors are not protected.
- Implement risk-adjusted premiums to the extent practicable; move away from actuarially unfair pricing.
- Strengthen supervision and capital regulation and apply least-cost resolution methods.
- Make national DGS mandatory and consider mergers of overlapping funds to expand the insurance pool.
- Prefund DGS funds over time with risk-based contributions; ensure sufficiently large funds in steady state while relying on government backstops for systemic crises.
- Harmonize coverage (including a broadly appropriate coverage level of €100,000), pricing, and funding across member states and move toward common funding within the banking union framework.

*Source: IMF staff chapter on deposit insurance agency mandate, coverage, funding, and harmonization as provided in the supplied content unit.*

### 2013. The views expressed in this document are those of the staff team and do not necessarily reflect

### DEPOSIT INSURANCE TECHNICAL NOTE — MARCH 2013

### I. Overview of existing deposit insurance arrangements in the EU
- Deposit insurance in the EU is provided by a variety of national deposit guarantee schemes (DGS) that "vary greatly in their coverage, contributions, fund sizes, and organizational setup."
- Some countries have more than one scheme; examples cited include Austria and Germany.
- Many national DGS have limited prefunding or rely on ex-post funding mechanisms:
  - Some countries (Austria, Italy, United Kingdom) "rely exclusively on ex post funding."
  - In 2011, the Netherlands adopted regulation to transform its ex-post DGS into an ex-ante funded scheme with risk-based contributions; the new regulatory framework will come into effect on July 1, 2013.
- Mandatory schemes can be supplemented by voluntary schemes; example:
  - The German private scheme for commercial banks provides insurance "of up to 30 percent of bank capital per depositor," effectively offering "essentially unlimited coverage for most depositors." This coverage is to be gradually reduced to 8.75 percent over a span of 10 years, starting in 2015.
- Typical measures of DGS breadth in 2011 (as presented in charts and tables):
  - Eligible deposits/GDP, Covered deposits/GDP, and DGS fund size/GDP vary significantly across member states (chart lists AUT, BEL, CYP, DEU, ESP, EST, FIN, FRA, GRC, IRL, ITA, LUX, MLT, NLD, PRT, SVK, SVN).

### II. Harmonization
- Harmonization timeline and instruments:
  - Process began with the 1994 EU Directive on Deposit Guarantee Schemes.
  - Directive was significantly amended after the failure of Lehman Brothers.
  - In 2010 the Commission proposed comprehensive reform of DGS in the EU; draft DGS Directive of July 2010 has been under discussion since 2010.
- Key harmonization aims and proposals (Commission draft legislation and related actions):
  - Create a level playing field, with focus on coverage limits and preference for ex ante funding.
  - Harmonize scope of coverage (type of deposits).
  - Introduce common standards on financing; proposed target fund size of 1.5 percent of eligible deposits (eventually to be set in terms of covered deposits).
  - Introduce risk-based contributions.
  - Shorten payout periods (proposal: limited to seven working days).
  - Clarify responsibilities to improve insurance payments for cross-border banks; limited cross-border borrowing arrangements between national DGS.
- Measures already implemented following the 2008 crisis:
  - Coverage level increased to €50,000 by mid–2009 and to €100,000 per depositor per bank by end–2010.
  - Maximum payout period shortened to 20 working days by end–2010.
- Political and procedural constraints:
  - Further harmonization suspended pending adoption of EU bank resolution arrangements through a new Directive on Bank Recovery and Resolution (BRR).
  - Co-legislators failed to reach compromise in 2011, mainly over potential use of DGS funds for resolution purposes in context of BRR.
  - BRR proposed a target pre-funding of 1 percent of guaranteed deposits within 10 years, and characterizes borrowing arrangements between resolution funds across countries while allowing for use of DGS funds for resolution if optimal protection of depositors.
  - Member states expressed willingness in July 2012 to pursue DGS negotiations in parallel with BRR negotiations.
- Key points of disagreement highlighted:
  - Disagreement about proposed size of funding (Commission original proposal: 1.5 percent of eligible deposits) and the proposed timeframe to build up funds (Commission original proposal: 10 years).
  - Impact assessments indicate building up these funds over the proposed timeframe could "significantly reduce the profitability of an already weakened banking sector" in several member states, particularly when combined with increased deposit coverage.
  - One member state indicated no desire to move to an ex ante scheme with prefunding from the industry.
- Cross-border payout facilitation:
  - EC proposed that the host country DGS acts as a "single point of contact" for depositors at branches in another member state (including paying out those depositors on behalf of the home country DGS, which would subsequently reimburse the host DGS).
- Relation to banking union:
  - These developments occur in the context of discussion on the banking union; proposed regulation establishing the Single Supervision Mechanism (SSM) was under consideration with a view to enter into force in 2013.
  - Although a pan-EU DGS was originally proposed, presently the SSM and establishment of the pan-EU bank resolution fund are given priority, with DGS harmonization to be pursued later.

### III. Principles and best practices for DGS
- Primary purposes of deposit insurance:
  - Provide a safety net for smaller depositors and enhance financial stability.
  - Serve as part of the overall "financial safety net" that includes bank supervision, emergency liquidity provision, and bank resolution/insolvency framework.
  - Distinction: guaranteeing (small) depositors vs. financing bank resolution.
- Variation in deposit insurer roles:
  - Roles range from broad responsibility to monitor the banking system and participate in insolvency proceedings, to being limited to depositor payout and asset resolution, or merely depositor payout.
  - Variation reflects differences in public policy objectives, institutional strengths, legal frameworks, and resource availability.
  - Within the EU single market, level playing field and cross-border contagion risks imply a need for harmonized safety nets and coordinated safety net agencies across member states.
- Core characteristics for credible deposit insurance:
  - Appropriate coverage:
    - Authorities can design coverage by reviewing deposit distribution, e.g., choosing a coverage level that fully protects "80 percent of depositors and 20 percent of deposits."
    - In practice, coverage levels per depositor average about twice per capita GDP but vary widely.
    - The €100,000 coverage limit can be seen as high for a number of EU member states with relatively low levels of economic and financial development; however, harmonized coverage levels are important for the single market to limit regulatory competition.
  - Timely payouts:
    - Payouts need to be timely to reduce disruptions to the payments system and prevent panics and bank runs.
    - Some jurisdictions achieve payouts within 48 hours of the failure.
    - Where banks are subject to corporate bankruptcy law rather than special bank insolvency regimes, shareholder appeals and strong creditors’ rights can impose significant delays on depositor reimbursement.
    - The principle of depositor preference (giving insured depositors and the DGS priority rights over the estate of a failed bank) is missing in a number of national bank resolution regimes in the EU; depositor preference could increase recovery by the deposit insurer and might facilitate quick depositor payout and transfer of deposits to another institution, but could also increase funding costs of banks by increasing potential loss exposure of unsecured creditors and causing shifts in unsecured funding when a bank faces distress.
  - Adequate funding:
    - Systems can be ex ante funded (built up over time with bank contributions) or ex post funded (extraordinary charges on all banks in event of failure).
    - Ex ante funding may strengthen private sector confidence and enhance financial stability, provided risk is correctly priced.
    - Ex post funding may induce market discipline but can be pro-cyclical and is regressive in that surviving banks bear the cost.
    - The Commission’s proposal calls for pre-funding of deposit insurance.
    - Government back-up funding is a prerequisite for credible deposit insurance to allow intertemporal smoothing of the fund; it can be used in case of shortfalls while money is recovered from surviving banks.
    - Convergence in treatment and ranking of depositor and other creditor claims in insolvency could promote cross-border cooperation and improve predictability of cross-border resolutions.

*Prepared by Luc Laeven (RES); research assistance from Lindsay Mollineaux acknowledged. International Monetary Fund, Monetary and Capital Markets Department.*

### 13.      The deposit insurance agency should operate with a clear mandate and within

### _cr1366 - 13.      The deposit insurance agency should operate with a clear mandate and within

### Mandate, legal framework, and public communication
- The mandate must be unambiguous, preferably spelled out in the law.
- The role of the deposit insurer must be well established within the larger problem bank resolution framework.
- The relationship with other agencies in the problem bank resolution framework must be explicit, with means of communication and information sharing laid out in regulation or law.
- The deposit insurance system must be informed immediately when a potential insolvency is identified so it can prepare for deposit payouts.
- Awareness of the deposit insurance system’s existence as well as the terms and scope of its coverage is critical to effectively stabilize depositor fears.
- Public outreach activities must be extensive and frequent.

### Limiting moral hazard: scope, pricing, and complementary policies
- Limited scope and coverage:
  - Deposit insurance risks displacing market discipline.
  - Coverage should relieve only small depositors of the burden of monitoring their banks.
  - The scope should exclude interbank deposits and “insider” deposits (i.e., those of bank managers, owners, and connected persons).
  - Shareholders and uninsured creditors of failed banks must not be protected.
- Risk-adjusted insurance premiums:
  - Banks should pay a fee commensurate to their relative risk of failure—i.e., higher premium for higher insurance risk.
  - Efforts should be made to adjust premiums for risk, for example, by assigning banks to risk buckets and charging different premiums for banks in each bucket.
  - Currently, most EU DGS do not adjust premiums for risk across banks and most levy premiums that do not adequately reflect the average risk in the system (that is, they are not actuarially fairly priced).
  - The proposed recast of the DGS Directive would alter this situation by introducing contributions that consist of both non-risk and risk-based elements.
- Strong supervision:
  - Deposit insurance should be complemented with strong supervision and capital regulation.
  - Strong supervision, particularly when combined with adequate capital requirements, limits unsafe and unsound banking practices and reduces the probability of failure, thereby protecting deposit insurance funds and enhancing stability.

### Funding, prefunding, and backstops
- Financial safety nets need to be backstopped with fiscal resources to lend credibility to the system and deal with systemic crisis events.
- The current system of national DGS within the EU lacks a fully credible backstop for systemic risks given the absence of mutual borrowing arrangements and concerns about the ability of individual member states to backstop their national DGS.
- National deposit guarantee schemes should be mandatory, not voluntary, to provide a level playing field, avoid adverse selection, and reduce the average cost of deposit insurance by expanding the insurance pool.
- Merging existing funds that operate in the same jurisdiction is generally preferable to expand the insurance pool; U.S. experience merging the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) into the Deposit Insurance Fund (DIF) under the Federal Deposit Insurance Reform Act of 2005 is cited as having broadly reduced the average cost of deposit insurance by expanding the insurance pool.
- Prefunding will be necessary:
  - The size of the DGS fund should be sufficiently large to cover depositor payouts and associated costs in case of bank failures in most cases.
  - Pre-funded schemes (in the steady state) could operate with funds that are fairly small in size, though substantially bigger than currently in most member states.
  - Funds should be raised over time from the financial sector to reach the target size, and contributions should be risk based.
  - In case of systemic crises, government backstops are needed; taxpayer costs associated with such backstops can be recouped over time from the financial sector.
- Operational detail from national practice:
  - To ensure banks have sufficient liquid assets to contribute such funds, all banks are required in one jurisdiction to invest a minimum of 2.5% of insured deposits in debt securities that are eligible for Eurosystem collateralization as defined by the Bank of Slovenia.

### Harmonization, cross-border issues, and the banking union
- Harmonization of deposit guarantee schemes across the EU is important to support financial integration and the functioning of the internal market.
- Current substantial differences in coverage, pricing, and funding arrangements across national DGS imply there is no level playing field and encourage regulatory arbitrage.
- To ensure a level playing field for cross-border retail banking, national deposit insurance schemes should be aligned:
  - In quantities through coverage limits, and in prices with fairly priced premiums adjusted for risk as far as possible.
  - The scope of deposit insurance should be aligned, being limited mainly to household and SME deposits.
  - The coverage level of €100,000 is broadly appropriate for most member states, given their level of economic and financial development.
  - Differential coverage would be undesirable given the objective to harmonize deposit guarantee schemes.
- In the context of the banking union, steps should be taken toward common funding of deposit insurance:
  - Resolution frameworks need enhancement and harmonization by giving insured depositors and the DGS priority rights over the estate of a failed bank.
  - A common safety net is a critical element of a banking union, ensuring funds are readily available to resolve individual bank failures and cover payouts to depositors without endangering sovereigns or monetary stability.
  - Common funding, not the operational centralization of deposit insurance, is emphasized as what matters.
  - Common or linked deposit insurance could be designed as a re-insurance scheme created from national deposit guarantee schemes and funded at the banking union level through industry levies and contributions from member states.
  - Over time, such a fund would build administrative capacity and could be a step toward a permanent banking union scheme and resolution fund.
- Until common safety nets are established:
  - Funding arrangements should ensure that bank failures can be resolved in an orderly and credible fashion, including rapid deposit payouts.
  - Prefunding combined with loss-sharing agreements for dealing with cross-border deposit payouts and a common, credible backstop should national deposit guarantee schemes run out of funds.

### Key policy recommendations (summary)
- Establish an unambiguous legal mandate for deposit insurers and explicit inter-agency communication and information-sharing arrangements.
- Limit scope of coverage to protect small depositors while excluding interbank and insider deposits and protecting shareholders and uninsured creditors from protection.
- Implement risk-adjusted premiums to the extent practicable; move away from actuarially unfair pricing.
- Strengthen supervision and capital regulation and apply least-cost resolution methods.
- Make national DGS mandatory and consider mergers of overlapping funds to expand the insurance pool.
- Prefund DGS funds over time with risk-based contributions; ensure sufficiently large funds in steady state while relying on government backstops for systemic crises.
- Harmonize coverage (including a broadly appropriate coverage level of €100,000), pricing, and funding across member states and move toward common funding within the banking union framework.

*Source: IMF staff chapter on deposit insurance agency mandate, coverage, funding, and harmonization as provided in the supplied content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1366.pdf_